Greece’s debt woes have dominated the news for months, but there may be just as much risk lurking in Latin America, especially if the dollar continues to strengthen.
South America is particularly squeezed at the moment, with the wheels of progress starting to grind to a halt in the continent’s major economies. The sharp fall in oil prices has compounded Brazil’s already parlous state. In late July, Standard & Poor’s warned the country was close to losing its investment grade credit rating.
Beset by inflation and stagnant growth, the real has weakened considerably against the dollar over the past 12 months. Added to that, China is a major trade partner, so slowing growth over the other side of the world is hitting Brazilian output as well.
Topping it off, the judiciary is rooting out corruption in Government and state-owned businesses. While clamping down on bribery and malfeasance is a good thing, the extent of the operation is causing much instability that is affecting markets. Recession is not far away for Brazil, and the Government’s plans to institute austerity could create the harshest downturn the country has seen in decades.
Fellow oil producer Venezuela has been hit with the same issues and is in even worse shape. Analysts say the country is likely to have to restructure its debt in the next 18 months, although an outright default is not expected. Meanwhile, Argentina remains at loggerheads with US hedge funds that are holding out on its latest debt restructuring. The economy has been sick for some time and many Argentine businesses are using crypto-currency bitcoin to circumvent capital controls in the country.
One area of LatAm that is, arguably, better positioned to deal with the pressures from tightening US monetary policy and the general regional slowdown is Mexico.
The country is closely aligned with the world’s largest economy, its northern neighbour, so an expected improvement in US consumption should trickle down into the Mexican economy. Despite headwinds from being an oil exporter during a period of bargain-basement energy prices, Mexico is looking to boost its crude industry by allowing private enterprise to enter the market for the first time in 80 years. These dynamics might make the country a good hedge: if the price of oil rises, the country should benefit, while sustained low prices for crude should increase consumer goods exports to the US.
When the US Federal Reserve starts hike in its interest rates, the pressure on emerging market debt is only going to increase, we believe. As the dollar strengthens, dollar-denominated repayments will become more onerous for countries that are collecting taxes in devalued currencies.
For investors that have invested in local currency debt in nations that are already stumbling, currency losses could cause severe losses. Added to that, investors could be expected to drop emerging market bonds in favour of better risk-adjusted returns elsewhere. It is shaping up to be a tough few years for emerging markets in the new world order.
Bryn Jones is fund manager on the Rathbone Strategic Bond Fund & Rathbone Ethical Bond Fund.